Buy This Microcap Paying an 8% Dividend

I enjoy studying companies in the microcap arena. They usually are overlooked stocks that often harbor a great idea that, if properly executed, can grow into a huge success over the years.

As long as the company isn’t 1) technology-related, 2) biotech/pharma-related or 3) an obvious penny stock piece of junk, I give these little guys a lot of time. It takes patience to buy a microcap and wait for it to really give you big returns, but they also are the breeding grounds for the elusive ten-bagger.

In the case of Collector’s Universe (CLCT[1]), however, the story is a bit different. I’m not actually sure how much of a growth play it is. Instead, this $140 million company (by market cap) appears to have a solid long-term, legacy business that produces a lot of cash flow — almost all of which is returned to shareholders as a dividend that is presently yielding a stunning 8%.

I remember Collector’s Universe because it published a magazine I’d buy when I was younger that I used to value my amateur coin collection, as well as my Star Wars poster collection. The company also is a signature brand name in the authentication and grading services arena, providing these services to dealers and collectors of high-value coins, trading cards, event tickets, autographs and memorabilia. It’s an important service because it enhances the marketability of collectibles and thereby provides increased liquidity to the dealers, collectors and consumers that trade them.

An authentication service relies on three things for success:

Brand recognition and awareness.

Reputation for integrity and consistency in grading standards.

Responsiveness of the service.

Brand is the biggest. You want to be able to trust the grading service because without that trust, the assignment of value to an illiquid asset makes that asset essentially worthless. Along those lines, Collector’s Universe has competition from other companies in the coin, trading card and autograph sector. However, CLCT thinks that only 10% of all collectibles have been graded or authenticated, leaving a lot of market share to capture.

That being said, my assumptions regarding Collector’s Universe are that it won’t increase market share at all. It certainly might grow its business, and if it did it would boost the stock price, and that would be great. However, revenue was only up 1.4% in FY13 over FY12. Operating income was up about 4%, but this follows a 10% increase from FY11 to FY12, so it suggests a flattening of growth.

The only reason I’m looking at CLCT is because of that 8% dividend, and to assess its sustainability. That means looking at free cash flow. In FY11, it was $10.57 million. In FY12, it came in at $10.8 million. In FY13, it delivered $9.05 million. Dividends paid were $9.94 million, $10.36 million and $10.8 million, respectively.

I’m not crazy that Collector’s Universe paid out $1.75 million more than it delivered in free cash flow this past year, so that takes us to the balance sheet. There’s $18.7 million of cash, so it’s more than enough to absorb that small shortfall — and to do so for many years to come, provided the company simply holds its own.

But can Collector’s Universe hold its own?

I’m not encouraged by CLCT’s drop in revenue growth and cash flow this year, but I don’t see a meltdown in process. I don’t see any earth-shattering news in this sector going forward, so I think this dividend is sustainable for some time to come.

CLCT stock has run up quite a bit this year, though. I think the play here is to see if the stock falls from the $16 range back to the $13-$14 range, just to give some downside hedge, and then buy. Unless cash flow and revenue decline significantly going forward, Collector’s Universe should pay that dividend for some time to come.

As of this writing, Lawrence Meyers[2] did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc.[3], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[4] and blogs about public policy, journalistic integrity, popular culture, and world affairs[5]. Contact him at pdlcapital66@gmail.com[6] and follow his tweets @ichabodscranium.